Monday, December 31, 2012

Happy New Year!

Though I am no longer managing a mutual fund portfolio, I continue to enjoy opining about investing through writing this blog.  I hope readers find it useful in making investment decisions, whether as professional investors or as amateur investors trying to grow--and protect--one's own portfolio.

This was a year when putting a portfolio in a stocks and bonds using index funds would have produced an excellent risk-adjusted return.  I expect that next year will not be so straightforward and that such an approach will yield much more modest returns.

Bonds have continued to produce amazing returns (except for U.S. Treasuries, finally).  High-yield bonds (actually more like equities than fixed income) and other corporate bonds have been excellent investments in recent years.  The need for investment income has pushed yields to such low levels that further declines in interest rates (which produce capital appreciation in bond portfolios) seem unlikely.

Despite the likelihood of a modest increase in tax rates on corporate dividends, there still are a number of high-quality stocks that have dividend yields that are higher than those on U.S. Government bonds (and shorter-term corporate bonds).  I still think the attractive starting dividend yields and likely dividend increases are attractive for investors who need some income from their investments.

After sharp gains in stock markets over the past six months--and even sharper gains over the past four years--I advocate holding some cash on hand for selloffs (and potential buying opportunities) that may arise.

Best wishes for a healthy, happy, and prosperous New Year!

Steve Lehman

S & P 500:  1405

Sunday, December 30, 2012

Stocks: Too High to Buy, Too Low to Sell

There often are times when the odds do not favor widespread buying or selling in the stock market.  That happens when indicators of valuation, price trends, and sentiment are mixed.  Stocks are not extraordinarily cheap or expensive.  Price trends are not notably depressed (and likely to recover) or sharply higher (and likely to decline).  Investor sentiment is neither gloomy (a good time to buy) nor ebullient (a good time to sell).

At such times, one needs to focus on individual stocks that are reasonably priced or on themes relating to a particular market sector or societal trend.  I think today is such a time.

I still find a small number of stocks that are attractively valued (VOD, AGXXF, AAPL, MOFG, KSS, FDP).  In general though, after the sharp rebound since June of this year and the doubling of major stock indexes over the past four years, I urge caution when considering making large new stock purchases.  This is despite a likely rebound in stock prices if elected officials in Washington make meaningful progress on spending and taxes.

Steve Lehman

S & P 500:  1402

Thursday, December 20, 2012

Depressed Assets After a Strong Year

In a year with significant gains in most U.S. stock prices as well as in other asset classes like corporate bonds and emerging market bonds, where can a contrarian look for depressed assets?  Gold and gold equities would be a place to start.

Though I wonder whether gold's 12-year bull market has ended, from a trading standpoint I think it is worth considering gold and gold equities.  The gold price is approaching oversold levels with fairly wide pessimism among market participants.  Gold equities are even more depressed, with several leading gold equities selling at 52-week lows, at a time when most major stock indexes and leading companies are selling near 52-week highs.

I have serious concerns over the social and environmental costs of gold mining.  Those who do not have those concerns might consider a trade in the SPDR gold exchange traded fund (GLD) or a stock like IAMGOLD (ticker:  IAG).  IAG has fallen 32% in the last three months, and it has net cash on the balance sheet and is trading for close to tangible book value per share.

Steve Lehman

GLD:  159
IAG:  11.17

Growing Caution Toward Stocks

The rebound in stock prices in recent weeks has pushed the market in general near overbought territory.  In addition, key sentiment measures reflect a sharp rebound in investor optimism.  

I recommend paring stock positions here, particularly in cases with sharp gains over the past six months.  I always like to have some cash available for buying opportunities, and now is a good time to begin to replenish cash after reaping significant gains.

Steve Lehman

 S & P 500:  1435

Monday, December 17, 2012

Is the Long Bull Market in Gold Over?

Back in 2000, I said publicly that I'd rather own gold than the Dow Jones Industrial Average.  The Dow was more than 40 times the price of an ounce of gold, which the UK government was selling at roughly $250 an ounce.  (At the peak gold price in 1980, the price of an ounce of gold was about the same at the Dow Jones Industrial Average.)  So it seemed likely to me that the Dow Jones and the price of gold would converge in price, not necessarily ending up at 1:1 but moving well away from 40:1.  Indeed, since the end of 2000, stock prices have had only modest gains, while gold rose more than six fold in price.

With gold headed for its amazing twelfth consecutive annual gain, when will its bull market end?  The conceptual case remains compelling, as central bank monetary policies are about as loose as they have ever been.  Short-term interest rates are near zero, and real interest rates (after subtracting inflation) are negative, which historically has been favorable for gold prices.  Central banks have been net buyers of gold for 19 consecutive months.  And it has become conventional wisdom that most investment portfolios should have a small allocation to gold, as a hedge against various negative outcomes.

But the price of gold peaked more than a year ago (in September 2011) at $1,921 an ounce.  It is now 11% below that.  Even though some esteemed investors, such as John Paulson and George Soros reportedly still have large gold holdings, the huge holdings of gold ETF's make me uneasy.  And in the financial crisis of 2008, gold was anything but a haven, as it plummeted along with other asset markets.

I no longer own any gold, partly because of the human and environmental toll that its mining entails.  I think there are more respectable, cleaner, ways to earn an investment return.

I had expected the end of gold's bull market to be marked by an explosive, "parabolic" spike, which hasn't happened yet.  And for gold to reach a new high on an inflation-adjusted basis would require a price of roughly $2,400 an ounce, 40% above current levels.  Either development would provide a large gain to holders of gold.

But I also wonder whether it is time to look elsewhere for an asset market that is underpriced and unpopular, and which provides favorable odds for significant gains.

Steve Lehman

Gold:  $1,700

Friday, December 14, 2012

Apple Stock--Becoming Ordinary or an Opportunity?

The decision to invest in Apple stock today is not as obvious as it was even a year ago.  The company is one of the most successful in the world, and it recently had the largest stock market value on record.  Great companies are often not great investments, however, because by the time the companies are widely revered their stock prices already have risen amply to reflect that greatness.  Has Apple fallen into that trap of a great company that becomes an ordinary investment?

I noted late in August amid the launch of IPhone5 when Apple set a record for total market capitalization of $625 billion (and a stock price close to $700), that it reminded me of the peak in the technology stock sector in 2000.  As in 2000, at the peak in the share price of Apple stock analysts were scrambling to revise higher their profit and share-price targets.  Price targets of $1,000 or more began popping up, as analysts seemed to want to outdo each other in being the biggest booster of Apple (as they did with Cisco's stock in 2000).

But starting price matters in investing, and despite the current dominance of Apple's business around the world, a starting price of $700 (and a market capitalization of more than $600 billion) for a company whose revenue base had become very large meant that future growth rates of revenues and earnings would inevitably slow in percentage terms due to the huge base.

The stock has since declined 25%, and earnings estimates have become almost ordinary.  The current consensus earnings forecast for the 2013 fiscal year (ending next September) is for earnings growth of 11%.  Have expectations for next year and beyond now become modest enough that the stock at its current starting price of $510 is a good buy?

There are several factors that make this a difficult call.  Though the stock is down nearly 30% since September, it is still up 34% over the past year and 157% over the past five years.  Earnings estimates have begun to trend lower, which is not favorable.  Furthermore, the stock is still very widely held, and if large, momentum-driven fund managers are unloading it because its stock price and earnings momentum have been broken, the selling pressure will be difficult to overcome.

One the other hand, one of the world's great companies now sells at a price/earnings ratio of 10.5 on current earnings, which would be less than 9 times if the company were able to use its net cash on the balance sheet to repurchase stock.  It is in superb financial condition with net cash equal to about 25% of its stock market capitalization, and excess cash flow could be available for dividend increases or share buybacks.

When I was a fund manager, I had little patience for the explanation of "profit taking" when stock prices declined.  I thought it was an excuse when people had no plausible fundamental reason for a decline in stock prices.  But perhaps part of Apple's price decline is indeed due to "profit taking" in anticipation of potentially higher capital gains tax rates next year.  That, plus selling pressure from momentum fund managers--amid recent news stories about greater competitive pressures from Google and others--have probably pushed the stock down to its current $510 price.

If I can invest in a superior company at close to ten times (current year) earnings, I'll typically do it regardless of my hunch about the stock market's overall direction.  Apple is a case where after significant gains in the broad stock market since early summer--and over the past four years--it is still possible to find such a stock.  

Steve Lehman

Apple:  $510

Thursday, December 13, 2012

Take profits in German Shares

For those investors who bought European stocks when sovereign debt crisis fears periodically spiked, notably early this summer, I commend you.  Gains likely range from 20-40%.  However, I now suggest looking to take profits at current levels, particularly in Germany.

The iShares MSCI Germany Index exchange-traded fund (EWG) is up 31% off the low in early June and is up 25% in 2012.  Under any circumstances, those are respectable gains.

However, the European economy seems likely to remain in recession or have sluggish growth next year, and the rise in share prices seems already to reflect improved prospects for economic growth or an abating of sovereign debt problems.

I still think stock markets will continue to rise over the near term, but I would look to rotate out of big winners into depressed shares that remain or start to build cash for those who are close to fully invested.

Steve Lehman

EWG:  $24.17 

Wednesday, December 12, 2012

Value in Retail

The significant rise in stock prices this year--on top of the sharp rebound over the past four years--has left few bargains.  There are, however, still some depressed stocks of good companies whose long-term prospects have become suspect.  Examples are Microsoft, Intel, and Kohl's.

Let's look today at the comparative value of Kohl's stock (symbol KSS).  The stock has recently dropped nearly 20% after the company reported disappointing sales results at its stores.  As a result, the stock has fallen 15% over the past year and 5% over the last five years.  The shares now sell for ten times current-year earnings, growth next year is forecast at 10%, and the company's return on equity is 17%.  Management has steadily repurchased shares, thereby increasing earnings per share and the scarcity of outstanding shares.  On the negative side, its earnings trends are comparatively poor, especially compared to those of peer TJX (parent of TJ Maxx and Marshall's).

But TJX stock is up 35% over the past year and 198% over the past five.  It clearly has earnings and price momentum, which is why it is so popular.  Earnings per share at TJX are forecast to rise 12% over the next year (not much more than Kohl's).  TJX shares seem pricey, at 17 times current-year earnings, versus only 10 at Kohl's.

For investors who pay attention to stock price charts, Kohl's has fallen to its current level of 43-44 several times over the past year and rebounded into the low to mid 50's each time.  I think there is a good chance that this will happen again.  Supported by a likely rise in the broad stock market, the prospect for a 25% gain in KSS seems like a good buy when shopping for stocks during this holiday season.

Steve Lehman

KSS:  43.35
TJX:  42.70

Tuesday, December 11, 2012

Santa Claus Rally to Continue

As a value investor, I find it difficult to participate in the stock market when prices are generally only fair, rather than cheap.  That is how I see the current market environment, with many stocks having risen significantly this year.  Yet, I still expect stock prices to continue to rally.  

During the market decline since September, I constructed a portfolio of undervalued and high-dividend yield stocks.  When I could no longer find individual stocks that met my purchase criteria, I added broad market participation through the SPY S & P 500 Index exchange-traded fund.

When technical and sentiment indicators signal that the broad market has become quite popular again with prices up sharply ("overbought"), I'll sell the broad market exposure and keep a core portfolio of individual stocks.  I still have a list of stocks that I intend to buy if they decline enough to reach my target purchase prices.

There are many confusing influences on stock prices at the moment, but I maintain that the likelihood is for a continued rise--though perhaps not new highs--in the major stock indexes.

Steve Lehman

S & P 500:  1430

Monday, December 3, 2012

Hewlett-Packard, "Goodwill," and Investing

Much has been written recently about Hewlett-Packard, once an esteemed leader in the technology sector.  Not only has the company (and its stock) suffered from reports of a huge shift in customer preference toward smart phones and table computers and away from personal computers and printers (Hewlett's most important products).  On top of that, Hewlett recently shocked investors by writing down nearly 90% of the value of its acquisition last year of Autonomy, a British software company.

Hewlett paid $11 billion to buy Autonomy in an attempt to shift its emphasis away from the obsolescent business of personal computers and printers.  Investors were stunned and frustrated by the huge premium HP paid, a price nearly twice what another reported bidder considered the value of Autonomy.  That was bad enough for investors, but last week Hewlett wrote down $8.8 billion of the $11 billion acquisition.  This was the latest example of the generally poor record of major corporate acquisitions that are later written down--or completely written off.

When a company buys another at a premium to the accounting value of its net assets (assets minus liabilities), the difference is put on the acquiring company's books as "goodwill."  Companies such as Procter & Gamble that have grown over the years by acquiring other companies (and products with valuable brand names) have large amounts of goodwill listed among their assets on the balance sheet.  In those cases, the brand value of, say, Gillette razor blades is considerable.  Such brands have maintained or even increased their value over time.  An investor in such a business would justifiably pay for the imbedded goodwill of such key products.

But for a business such as technology, with its risk of rapid obsolescence, it is dubious to pay a high premium.  Hewlett had already stumbled with its acquisition of Electronic Data Systems several years back.  EDS, a former subsidiary of General Motors, was heavily dependent on business from GM, and when GM struggled in recent years, so did EDS.    Such write downs of poor acquisitions result in a reduction of stockholders' equity, or book value.  

I pay attention to a company's book value, or more important, its tangible book value (after deducting goodwill and other intangible assets).  For a company with valuable brand names such as Apple or Coca-Cola, tangible book value might be considered irrelevant in assessing the true value of the business.  But for companies in other sectors with hard assets, or businesses with commodity-like assets like many technology companies, I would not pay a large premium over tangible book value.

In general, the record of large corporate acquisitions is mixed, at best.  I generally prefer a company whose management does not make large acquisitions that dilute the investment of existing shareholders (by issuing large amounts of additional shares of stock to pay for the acquisition).  Managers who behave like owners, rather than highly-paid consultants looking for a quick payout, are better.

The poor decisions at Hewlett were made under the prior CEO, though most the board of directors that approved the deals is still there.  So, it is hard to have confidence in management today.  

Yet, the stock has declined 53% over the past year and 74% over the past five years.  Its price/earnings ratio is now 3.9.  Though it has substantial debt, its cash generation is considerable.  With its total stock market capitalization now down to $25 billion, could it be attractive for takeover by a private equity firm?  Or is it at least now sufficiently undervalued to offer a "margin of safety" in buying the stock?  I'm not ready to go that far, but the stock is worth a closer look at this point for its valuation and 4% dividend yield.

Steve Lehman

HPQ:  $13